Ch 3- The Problems With Conventional Accounting

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CHAPTER 2:CHAPTER 2: THE PROBLEMS WITH CONVENTIONAL ACCOUNTINGAND IMPLICATIONS FOR ISLAMIC ACCOUNTING

Alternative (conventional accounting) rules may, for the individual citizen, mean the difference between employment and unemployment,reliable products and dangerous ones, enriching experiences and oppressive ones, stimulating work environments and dehumanising ones,

care and compassion for the old and sick versus intolerance and resentment. (Tinker, 1985, p xx)

2.02.0 INTRODUCTION AND CHAPTER OUTLINE:

In the previous chapter (chapter 2), the researcher outlined the world view and value system

of Islam and compared it with that of the Western worldview; he highlighted the consequent

economic implications and the accounting implications of these differences. In this chapter,

the critique of conventional accounting from the social and critical literature and behavioural

accounting literature will be reviewed. The review is undertaken through five main themes:

objectives, fundamental assumptions, characteristics, macro-consequences (effect on social

and environmental well being) and micro consequences (i.e. internal behavioural

consequences). During the course of the review, the researcher will attempt to extend this

literature through an addition of an Islamic perspective to this critique. The aim of this

chapter is to examine why the objectives, characteristics and consequences of conventional


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accounting and its behavioral implications are unsuitable for an Islamic society, using the

social, critical and Islamic critique of conventional accounting.

This analysis will attempt to answer the following questions: (i) what are the objectives of

conventional accounting (based on the capitalist economic system) and are these

acceptable from an Islamic economic point of view? (ii) What are the fundamental

assumptions of conventional accounting and do these hold for the existing and desired

socioeconomic framework of Muslim and Islamic societies? (iii) What are the social and

economic consequences of conventional accounting and are these consistent with the

objectives and norms of Islamic society and organisations? (iv) Are the

measurement/valuation and disclosure principles and practices of conventional accounting

appropriate for Islamic society? (v) What are the internal and external behavioural

consequences of accounting for Muslim managers and employees, and are these are in line

with Islamic values?

The researcher argues that conventional accounting in terms of its objectives, characteristics

and consequences is a negative force from an Islamic perspective and classifies these

characteristics as the push factors necessitating the search for an alternative Islamic

accounting.

In the next section (3.1), an outline of the critique of conventional accounting literature is

given. Next, an examination of the critique with respect to the objectives, assumptions

(section 3.2), accounting concepts and characteristics (section 3.3) and the economic, social

and environmental consequences of conventional accounting (section 3.4) is undertaken. In

section 3.5, the management accounting and the critical accounting literatures relating to

budgeting and control systems will be used in considering the behavioural effects of

management accounting and financial reporting on employees and management. Section

3.6 adds an Islamic perspective to the traditional critique of conventional accounting

This chapter is concluded (section 3.7) with a summary of the arguments and a model of the

push factors depicting the need for Islamic accounting. The next two chapters (chapters 4


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and 5) will discuss the pull factors which express the theoretical and practical need for

Islamic accounting.

The same themes using objectives, characteristics, consequences and behavioural effects

will be used as basis to explore the issues and remedies which have been suggested in the

Islamic accounting literature, in Chapter 6. This procedure will help in identifying the

objectives and nature of Islamic accounting, which will satisfy the need of Muslim users and

organisations

2.12.1 AN OUTLINE OF VARIOUS ACCOUNTING CRITIQUES.

The literature, which criticises conventional accounting, draws on various perspectives:

i) Social and environmental accounting (Maunders & Burrit, 1991; Gray et al., 1996; Gray

& Bebbington, 1998),

ii) Marxist/ critical accounting (Tinker et al., 1982; Tinker, 1985; Cooper & Hopper, 1990;

Lehman, 1992a; Galhlhofer & Haslam, 1995),

iii) Feminist critiques (Cooper, 1992; Reiter, 1997) and

iv) Public interest arguments (Arrington, 1990, Briloff, 1990).

Although all of the different critique of conventional accounting point out its deficiencies from

their own perspectives, many of the issues raised are common to which Islamic academics

would have concerns. Some of the concerns about the application of conventional

accounting to Islamic societies are similar to that raised by researchers in other areas. In

spite of this, not all the concerns of Islamic societies are addressed by these critiques as

they all represent variants of the Western worldview (in both its capitalist and Marxist

forms). Therefore, the critics agree with many of the capitalist systems core principles.

Further, they specifically exclude a religious content due to the ontological and

epistemological differences between Islam and the history of secularisation of knowledge in

Western society. The researcher attempts to highlight these differences especially when the

values or proposed solutions are not compatible with an Islamic framework.


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However in all fairness, it must be said, that these different views do try to avoid or lessen

the worst excesses of modern capitalism in which conventional accounting is embedded.

Despite their common worldview at the fundamental level, the mainstream of Western

thought- itself dominated and captured by capitalist, individualist and utilitarian ideologies-

do not allow them to be very successful. This can be seen from the fact their

recommendations are not adopted in mainstream accounting practice and do not take pride

of place in mainstream accounting research (e.g. Tinker et al., 1991; Lehman, 1992a; Lee,

1997).

There is no dearth of criticism of conventional accounting. The criticism began soon after

accounting started to grow in prominence and stature in the early part of this century: this

was especially the case in the USA and the UK where modern corporate accounting can be

said to originate. Early accounting critiques were based mainly on the problem of obtaining a

true income figure. Very few academics with the exception of writers such as MacNeal

(1970 [1939]) criticised the accounting principles and valuation methods and tried to infuse a

moral consciousness and public spirit into the profession. Writers such as Sprague (1971,

[1922]) and Scott (1931) focused on the Philosophy of accounts and the cultural

significance of accounts respectively.

Accounting has faced ever-increasing criticism since it became an important discipline and a

profession in the early part of this century. In its attempt to become a respectable discipline

akin to that of Law and Medicine, the AICPA (and their academic counterparts- the American

Accounting Association), attempted to develop a theory of accounting (AAA, 1936;1966;

1977).

However, the various schools (multiparadigm) (AAA, 1977), and various images of

accounting (Davies et al., 1982) attracted criticisms especially on the valuation and income

determination aspects of accounting, sometimes dubbed the true income school (AAA,

1977). Until the late 1970s, when the decision-usefulness paradigm took over conventional


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accounting (ASSC, 1975; FASB 1978), the true income problem, constituted the subject of

most accounting debate.

The prominence of Accounting as a social institution (Roslender, 1992), owes much to the

development of corporations as major business organisations in the early part of this

century. In fact, one can say, accounting achieved prominence as a profession in tandem

with the growth and diffusion of the corporate enterprise in the USA, UK and its spread in the

form of the multinational corporation. It was not too long ago that corporations were relatively

small; however, they have become very large and hold a significant amount of power and

wealth to such an extent that some have become wealthier than certain governments and

countries. The rise of Managerial Capitalism (Chandler, 1977), or Investor capitalism

(Bryer, 1993a) led to the concentration of power and wealth in the hands of a few people.

This resulted in a greater emphasis on market efficiency and shareholder value in society

with the associated environmental destruction, nihilistic consumerism, wealth appropriation

and social conflicts. This phenomenon also gave prominence to the accounting profession in

the guise of multinational audit firms especially the Big Six (now the Big four). The critique of

these excesses of the corporation started in the 1970s when their social costs became

staggering and could not be ignored. This led to a debate regarding the moral and social

responsibility of corporations (e.g. Donaldson, 1982; Mintzberg, 1983) and extended to

corporate accounting and governance, e.g. Gray et al., (1988,1991) and Benston (1982).

The Corporate Report (ASSC, 1975) was an attempt to incorporate the social responsibility

of corporations in accounting although it adopted a decision-usefulness framework.

The true income school and corporate social responsibility debate gave way to development

of a theoretical framework for accounting in the guise of a search for a conceptual

framework; as accountants sought a theoretical justification for professional status akin to

medicine and law. After a series of attempts to develop statements on objectives,

conventions and postulates of accounting, for example, with the Trueblood report, (AICPA ,

1973), the FASB completed its conceptual framework project resulting in the Statements of

Financial Accounting Concepts (FASB, 1985). However, this attempt according to Solomons


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(1986) missed the chance to revolutionise accounting; nevertheless it established for

accounting a particular decision-usefulness framework which emphasised the focus on

investors and creditors in the capital market. In the researchers opinion, it was a typical

Friedmanian approach to conceptualizing accounting as an objective, neutral tool of profit

maximizing business based on the capitalist society and world-view1.

From the late 1960s, a capital market orientation in accounting research and theory

development arose out of criticism of armchair theorising (AAA, 1977). Instead of trying to

develop the notion of true income or of thinking about what accounting ought to be, the

positive accounting theorists argued that accounting should study what is and try to

investigate whether financial statements could predict future events (Watts & Zimmerman ,

1979 and 1986). Capital market studies such as Ball & Brown (1968), Beaver (1981) and

Watts & Zimmerman (1979 and 1986), together with agency theory (Jensen & Meckling,

1976) which assumed that people are self-seeking zealots, led accounting away from moral

and social issues to concentrate on increasing the wealth of finance providers and market

players. This became the mainstream of accounting research and the primary focus of

practice which saw finance and financial markets develop as important disciplines in their

own right, separate from that of accounting.

This capitalistic orientation has attracted a great deal of Marxist critique of accounting

which argues that accounting is merely a tool which increases the gap between the rich and

the poor and leads to class conflicts (Tinker, 1985; Lehman, 1992a ). Marxists also

launched their attacks through the medium of critical theory (e.g. Laughlin, 1987; Cooper &

Hopper, 1990). This theoretical approach was an offspring of the Frankfurt School

expounded by Max Horkheimer (1895-1973) according to which only a radical change in

theory and practice can cure the ills of modern society, especially unbridled technology; in

turn it attacked Marxism itself as a one-sided doctrine subject to criticism (Honderich, 1995,

p290). Further critical theory contends that since theory and its concepts are products of

social processes and therefore, instead of accepting and endorsing them as they are, as

1 [1] See the emphasis and rationale of resource allocation efficiency arguments in SFAC No.1 (FASB, 1978).


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positivism and empiricism does, it should trace their origins (cf. historical materialism of

Marx)

The Critical school is also used by Feminist and Deep Green groups who have criticised

accounting (Cooper, 1992; Reiter, 1997). Radical Feminists hold that accounting promotes

male chauvinism and that a feminine perspective would give accounting much needed

balance as well as reducing male superiority (Cooper, 1992). The Deep Green perspective

on the other hand views modern society as unsustainable; their extreme proponents insist

on human depopulation to let the animals and plants reclaim their portion of world. They

view corporations and accounting as agents for the destruction and pollution of the

environment and the biosphere (Maunders & Burritt, 1991).

A Public-Interest perspective is taken by writers like Briloff (1990), who argue that

Accountants have not honoured their duties of public service by shamelessly paying littler

attention to their ethical codes and by being involved in a number of high profile scandals.

The Social and Environmental Accounting writers criticise modern accounting from

various perspectives mentioned above. However, its main advocates (e.g. Gray et al., 1996;

Matthews, 1994) favour an evolutionary approach of extending conventional accounting to

recognise, report and disclose social and environmental information leading to their

discharge of accountability to society.

Finally, a critical cultural perspective has developed which argues that accounting has

cultural relevance and should be tuned to the cultural idiosyncrasies of space and time

especially in the different cultural and economic environments of developing countries

(Perera, 1989). Writings in this area range from culturally developed accounting (Wallace,

1990a) to those which question the relevance of conventional accounting to other cultures

(Baydoun & Willet, 1995).

From a management accounting perspective, critique has focused on two main issues i.e.

the behavioural problems (Argyris, 1953 and 1990) and the of management control of the

individual and society (Miller & OLeary, 1987).


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All the above perspectives have lessons, which can be learned by Islamic accounting.

However to focus the research, this review will concentrate mainly on, the social and the

critical accounting literature, including the Marxist critique of accounting. The critical school

share similar concerns to the researcher, as the research is an attempt to look into the ills of

society and to emancipate and change it for the better. The social accounting school

provides some lessons on how the fundamental philosophies underlying conventional

accounting can be recognised and serves as an example of an evolutionary method to

change the status quo (a method favoured by Islam). The accounting principles and true

income debate raises some issues of concern to the content of Islamic accounting. The

public interest accounting literature being mainly concerned with the failure of the accounting

profession is not reviewed, as this research does not concern itself with this issue in any

detail. The feminist critique is not discussed except to take some lessons for Islamic

accounting from enabling accounting (Reiter, 1997).

The discussion starts in the next section with the objectives and assumptions of conventional

accounting.

THE OBJECTIVES AND ASSUMPTIONS OF CONVENTIONAL ACCOUNTING:

SOME PROBLEMS WITH THE DECISION USEFULNESS PARADIGM.

From the period 1977-1985, the Financial Accounting Standards Board of the United States

of America spent millions of dollars and thousands of man hours trying to develop some

theoretical basis for accounting in the form of a conceptual framework. This was supposed to

be a coherent system of inter-related objectives and fundamentals ...that prescribes the

nature, functions, and limits of financial accounting and reporting (FASB, 1981). Their project

resulted in six Statements of Financial Accounting Concepts (SFAC). SFAC No. 1 (FASB,

1978) states that:

Financial Reporting should provide information that is useful to present and potential

investors and creditors and other users in making rational investment, credit and

similar decisions ...(through the provision of information that will help them to

assess)..... the amount, timing and uncertainty of net cash inflows to the relatedenterprise. (FASB, 1978, p16 &18)


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The objective was not new (except in the importance given to cash flow) as this decision

usefulness objective, which has become the main paradigm of accounting, had been

emphasized before the FASBs conceptual framework project began. (See for example,

(AAA, 1966 & 1977; ASSC 1975). In fact the American Accounting Association (AAA, 1977)

attributes Chambers (1955) article on the Blueprint for a theory of accounting as having

served as the starting point for a decision-usefulness theory of accounting. All the

pronouncements of AAA and the conceptual framework projects led to the dominance of this

paradigm. The main stream capital market research is an outcome of a particular variant of

this paradigm i.e. on the aggregate behaviour of decision makers (i.e. Market players) as

depicted by changes in security prices (e.g. Ball & Brown, 1968; Beaver et al.,1968).

Lehman (1992a) notes the change of emphasis from stewardship to decision usefulness or

decision informativeness from the AICPAs Study Group report on Objectives. He contends

that the traditional stewardship role always necessitated considering managements

effectiveness and efficiency, despite the tendency to justify this slant towards decision

usefulness as a higher form of stewardship (p20). The difference is not superfluous but

calculated to emphasise the informational role of accounting being regarded as crucial to

the efficient allocation of societys resources by individuals, enterprises and government

(p21). Combined with agency theory and positive accounting theory, this became the

dominant paradigm of accounting in the 1990s; adoption by the FASBs conceptual

framework project probably added to its central role. In fact, decision-usefulness has

become the dominant paradigm of all subsequent conceptual frameworks since the FASBs

first pronouncements on the issue (for example, IASC, 1989; ASB, 1992).

On the face of it, the term decision-usefulness seems rational, innocuous, and perfectly

acceptable from an Islamic perspective. However, when one examines the concept in depth,

a number of problems arise. These include (a) the economic-environmental context in which

it was developed and therefore the environment under which it may be appropriate; (b) the

economic assumptions underlying decision-usefulness, the under-specification and


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achievability of social welfare; (c) the decision-users who are targeted; and (d) the societal

assumptions underlying decision-usefulness.

Each of these will be examined in turn.

The Economic Environment of Decision Usefulness

The decision-usefulness paradigm was born in the United States and spread to the UK as

noted above. In the3e countries, the underlying economic environment is very different from

that which operates in Muslim countries. The United States and the UK are advanced

exchange-based economies with developed capital markets. It is in this economic context

that the decision-usefulness paradigm was arrived at. In discussing the environmental

context of the objectives of financial reporting, the Statement of Financial Accounting

Concept 1 (FASB, 1978) notes that:

The US is a highly developed exchange economy where large amounts of capital is

required for maintaining the complex production processes which result in the

production and exchange of goods and services. These processes require economic

resources, which is allocated by the market mechanism. The effectiveness of individuals

(through buying, selling or holding shares & bonds) and enterprises, markets and

government in allocating scarce resources among competing uses is enhanced (.i.e.

allocated to enterprises that use them efficiently) if those who make economic decisions

have information regarding the standing and performance of business. (FASB, 1978, p

5-8).

In this context, competitive markets are seen as a significant factor in resource allocation in

the economy (in addition to government whose intervention is frowned upon). Thus,

decision usefulness relies heavily upon the language of self-seeking rationality, markets and

economic efficiency to describe accounting problems and interpret accounting events

(Williams, 1987).

While, these objectives may be valid in the developed economies of the West, it may not be

suitable in economies such as those of Muslim countries where the economic realities are

different. For example, many Muslim countries do not have established or developed stock

exchanges. Many industries are government owned (although privatisation has started in

earnest in Malaysia, Pakistan, Turkey and Egypt). A large section of the economy is non-

monetised and most people are involved in agriculture which do not produce huge financial


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surpluses. In such situations, a decision-usefulness form of accounting oriented towards

market participants does not make a great deal of social or economic sense except as a tool

for overseas capitalists interested in appropriating the wealth of these countries (see Tinker,

1985). In Muslim countries where stock exchanges are fairly developed (such as Malaysia),

the decision-usefulness orientation serves the same role as in the West with the same

undesirable consequences of financial hyperreality (McGoun, 1997) ; these consequences

are not desirable from an Islamic perspective. Therefore, the basis and thrust of accounting

needs to be changed.

The Ceteris Paribus of Decision Usefulness.

The essential message of decision usefulness is that accounting provides information whichleads to the efficient allocation of resources (AAA, 1977). This is apparently through theprocess of providing information, which results in information efficiency in the market, whichin turn leads to allocation efficiency. Although efficiency (the most output per unit of input)may well be a useful goal to aim for, it cannot be the ultimate aim of human society. It is anintervening variable which perhaps leads to a better life or more utility (perhaps at least inthe material sense). This deficiency has led a committee of the American AccountingAssociation (AAA, 1975) to add social welfare as the ultimate aim of allocation efficiency.

Commenting on the inadequacy of a report by the Study Group on Objectives of FinancialStatements (AICPA, 1973), this committee (AAA, 1975) observed that the Study Groupsassertion that financial statements should provide information useful for making decisions ,was not broad enough to lead a complete set of criteria against which accountingalternatives should be judged (p 42). It suggested that decision usefulness was a necessarybut not a sufficient condition. It argued that Financial Statement alternatives should bejudged by their impact on social welfare. Hence it is proposed that the objectives of financialstatements should be, to provide information which is potentially useful for makingeconomic decisions and which if provided, will enhance the maximisation of social welfare(AAA, 1975, p 42).The above discussion can be summarised in the following figure (3-1). If decision-usefulness is adopted as the objective of accounting, then it is posited that social welfarethrough the following processes:

Figure 3Figure 3--1: Accounting route to social welfare1: Accounting route to social welfare

Better Economic Decisions

Social Welfare

Accounting

Information Efficiency


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Efficient Allocation of Resources

Leaving aside the definition of social welfare for the moment, (discussed in section 3.2.3.),

the question arises, does conventional accounting really lead to social welfare (even in the

material sense) through the chain depicted in figure 3-1 above? In other words, does

accounting information lead to information efficiency, does this in turn lead to the right

decisions, do these decisions lead to efficient allocation of resources, and does the efficient

allocation of resources lead to social welfare? The probability that all these assumptions hold

might be dubious.

Lehman (1992a) argues that the assumption that if accounting information is provided to

investors, the marketplace will function efficiently, ensuring maximum social welfare (p 22)

has some limitations. He contends that there are fundamental problems with the use of neo-

classical economic model (on which conventional accounting research relies heavily), that

makes this chain dubious. These include:


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(i) The breakdown of the assumption about perfect competition leads to inconsistencies

and problematic implications for the role of accounting. Some researchers (e.g.

Benston, 1982) contend that there is no need to regulate accounting as markets are

efficient by themselves. Other researchers (e.g. Ronen, 1979 as quoted in Lehman,

1992) argue the importance of accounting in regulating behaviour because of

information asymmetry between management and investors. The question therefore

arises as to whether accounting leads to efficient allocation of resources or whether

markets are efficient in spite of accounting regulation.

(ii) The generalisation of individual preferences to collective preferences by aggregating

individual utilities of shareholders who have heterogeneous interests, to obtain

societys collective preferences is questionable. This has been questioned by Arrow

(1971) (as quoted by Lehman, 1992), who concludes that it would take a dictator to

make social choices affecting more than one individual. This has resulted in the

recognition by Beaver & Demski (1974) that choice among reporting alternatives has

social consequences that affect non-users and users of accounting information in

terms of the distribution of wealth. Hence, ethical judgements must be made as to

whose well being should be enhanced and whose should be diminished.

(iii) The separation of social and economic spheres of analysis is another assumption,

which has been questioned. For example, Lehman (1992) contends these two

spheres cannot be separated. He questions the maxim that it is inappropriate for

accounting to consider the distribution of resources of income and wealth while at the

same time insisting that it leads to social welfare by maximising wealth. It is not

logically possible to develop production conditions independent of distribution

conditions. The neo-classical economic model (marginal productivity theory), by

seeking to ignore income and wealth distribution becomes a tautology as when

determining the optimal vector of factor input prices, one needs to assume a given

distribution of income, which in turn is what the model tries to explain.

Gray et al., (1996) put this problem as the case of too many ifs. Thus:


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Ifall agents were equal, and ifmarkets were information efficient and if, ,this led to

allocative efficiency and if, this led in turn to economic growth and if , this ensured

maximum social welfare and if, maximum social welfare is the aim of the society then

accounting is morally, economically and socially justifiable.

(Gray et al., 1996, p 17).

The Question of Social Welfare:

The introduction of the term social welfare leads to more questions than answers. Social

welfare obviously means the welfare and goodness of the community. However, welfare

and goodness again depend on the value system of the community. The differences

between the values of Western civilization and those of Islam have been discussed in

chapter 2. Although there are similarities in moral values (Kants categorical imperatives),

the modernist and post-modernist trends of Western civilization are not identical with Islam

and have many differences. Hence, social welfare in Islam might mean equitable distribution

of wealth in an Islamic economy, equal distribution in the communist system, and

concentration of wealth to the ones who make use of opportunity in the capitalist system.

Another instance would be perhaps, in the West, welfare may be measured more in material

terms, while the Muslim might trade-off some return in favor of religion (El-Ashker, 1987) or

other ethical objectives. Even in the West, ethical investors may trade-off some monetary

return in favour of ethical /religious values (EIRIS, 1993). Hence, social welfare may be

culturally defined.

Even if social welfare is defined in pure economic terms, the provision of decision useful

accounting information may not lead to its achievement because of the operation of the so

called Lipsey-Lancaster Theorem (Laughlin & Puxty, 1981, p63). Thus:

Social Welfare cannot be appealed to by suggesting that, if users needs are satisfied,

greater welfare will result, because of the operation of the Lipsey-Lancaster Theorem"

(Laughlin & Puxty, 1981, p46).

This Lipsey-Lancaster theorem argues that, in a non pareto-optimal world, removal of one

constraint to a pareto-optimal situation (e.g. lack of accounting information disclosure) may

affect welfare or efficiency either by raising it, by lowering it or by leaving it unchanged.

(Lipsey & Lancaster, 1957, as quoted by Laughlin & Puxty, 1981). Thus, Laughlin & Puxty


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(1981) argue that the direction of change in social welfare cannot be forecast simply from

the direction of change (of the constraint) itself and therefore further investigation is

necessary.

Thus increasing decision useful information may lead to an increase, decrease or no change

in social welfare, not necessarily an increase all the time. A further consideration is that

decision usefulness does not elaborate on what uses the information is put to by users. Such

disclosure can actually harm the organisation and society (at least locally). For example,

Laughlin & Puxty (1981) quote the example of (i) a self-interested union that makes use of

information to force a firm out of business by insisting on high pay and (ii) the social

consequences arising for a particular geographical area which was dependent on the

business. In this case, decision-usefulness was not useful to the local community.

In certain cases, firms may wish to restrict information disclosure i.e. in the case where a

firm exploits a gap in the market and exploits arbitrage opportunities and in the case where

they have come up with better techniques of production due to their research and

development activities. In this case, the disclosure of segmental information useful to

users would lead to the entry of competitors resulting in loss on the part of the firm

disclosing the segmental information. Laughlin & Puxty (1981) argue that this ability to keep

trade secrets (non-disclosure of information) is important if there is to be continuous

incentive to develop new products and services and the continued operation of businesses.

Another pertinent question to ask is who are the targeted users for whom the accounting

information is useful and is an increase in their welfare synonymous with all or even major

sections of society?

Cooper & Sherer (1984) point out that

Focussing on informational efficiency in the capital market may contribute towards an

efficient allocation of resources from the perspective of the shareholder class, but the

resulting equilibrium may not be efficient for other members of society. (Cooper &

Sherer, 1984, p211).

Further, Lehman (1992a) argues that the heterogeneous interests of the shareholders are

not representative of the interests of all social members but conventional accounting


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assumes that it is. Thus, maximisation of shareholder investment wealth does not

guarantee an adequate criterion for societal wealth (financial or non-financial) (p22). This

point is particularly pertinent as, even in the case of a developed country such as the UK,

less than 30% of the public are direct investors in the share-market (Mullin, 1998). In

developing countries, especially Muslim countries, this percentage is even less. Hence this

point is particularly valid for Muslim countries who do not have developed stock markets and

who may not wish to construct wealth-siphoning structures in their countries.

The Societal Assumptions of Decision-usefulness

Accounting is normally seen as a complex set of socially neutral techniques which are value

free and objective. However, the reality is that accounting is a social construction (Hines,

1988). Gray et al. (1996) warns us that reductionism leads to artificial systems boundaries

around those parts we might choose to ignore (e.g. ethics, values, exploitation, and the

natural environment). Using the General Systems Theory framework, they assert that

accounting, ecology, society, organisations etc., are all systems, which interact. These

systems can be conceptualised and their interaction conceived of differently. They assert

that role of accounting can be better understood if the world in which it is assumed to

operate is made explicit.

They posit that accounting (in the Western developed world) operates under an assumed

pristine liberal economic democracy (p14). This assumed society, under which accounting

operates, is a world of equal individuals (or groups) who are free to act (liberal) and to

express choice through actions in markets (economic) and actions in the political

(democratic) arena. The role of the (small) government is to maintain their freedom and be

neutral with respect to serving particular interest groups in society. Hence an individuals

freedom is paramount and all are equally able and free to exercise their political and

economic choices through the ballot box and in the market. The self-interested pursuit of

economic efficiency ensures that profit and economic growth is maximised making society


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accountability and fairness must be added to the lexicon of accounting. He posits two

conceptual problems with decision usefulness: the asymmetry of decision usefulness and

ignoring the simultaneity of efficiency and distributive effects.

The asymmetry of decision-usefulness arises from the non-substitutability of the dual role

played by it; as a criterion for making judgements about the value of accounting data and as

an explanation of the phenomenon the accounting data represent. The consequence of this

asymmetry is that contradictions are created; for example , in the case of the FASB project

between SFAC 1, objective and the constraints imposed in SFAC2 , Qualitative

characteristics. According to Williams, there is no necessary property to explain these

constraints on the production of accounting data. Accountability on the other hand, is a more

appropriate principle as it implies constraints and possesses fairness as an inherent

property.

The second problem asserted by Williams is that the rationale of decision usefulness in the

efficient allocation of resources is problematic because it ignores issues about the

distribution of those resources. He argues that Efficiency or allocation is but one aspect of

a two-aspect process (p176). Although accountants seem to ignore the problem, they

implicitly make normative value judgements on distribution e.g. by using price theory (Tinker

et al., 1982). He also suggests that reliance on the efficiency criteria and market justice only

serves to make accountings fairness judgement implicit not absent (p185). Since these

interpretations of accountings reliance on such devices lead to the conclusion that fairness

is not assured, more explicit concern with fairness is required. This implies a moral

dimension to accounting, which in turn has consequences for the design of accounting

systems and semantic interpretations of accounting numbers. Labels such as profit,

dividends, contribution etc. take on different meanings if defined from a perspective of

fairness rather than decision-usefulness.

The Dysfunctional Effects of Decision Usefulness:


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Laughlin & Puxty (1981) also point out that decision usefulness could lead to possible

dysfunctional policy decisions of organisations as a consequence of accounting standards

which are based on users needs. In this case, businessmen may be obliged to act in a way,

harmful to their firms. For example, property development companies would have had to split

up their operations into property development and property investing and pay substantially

more tax, if they had, had to adopt the provisions of SSAP 12. Although these companies

were exempted in the UK, companies in the US were not spared the negative economic and

organisational consequences of the introduction of SAS 8 on Foreign exchange transactions.

Laughlin & Puxty (1981) blame the myopia of decision usefulness on the misinformed

dichotomy between external and internal accounting which ignores the control nature of all

accounting information and the need to take account of the reporting entitys needs in

financial reports (p74). They suggest an alternative framework of organisational control

which they claim can lead to social welfare (under specified conditions).

They posit that internal and external accounting should be designed in such a way so as to

meet the needs of the organisation i.e. the content should be such that it increases

organisational effectiveness in terms of goal achievement. Under this framework , the major

function of accounting would be to act as a regulator to reduce the effect of environmental

disturbances on the organisation because the disturbances make it difficult for the

organisation to achieve its objectives by changes in the controllable elements (internal

accounting). Another control model proposed is to use both accounting and systems design

to directly attempt to affect the environmental state so that the objectives might be furthered

by making the environmental constraints less damaging.

How this leads to social welfare is explained by (Laughlin & Puxty, 1981) using the

inducement-contribution theory. This theory states that an organisation continues to exists as

long as its inducements to participants is greater than the contributions it needs from them.

As long as this happens, it is contributing towards social welfare (at least that of the

participants). The authors attempt to extend this argument to the whole of society by

presuming that a viable society in course of development, depends on the continued


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viability of the enterprises which constitute it. Since viability implies control, societal welfare

depends on adapting the enterprises ability to control their relationship with society (p77).

Conclusions on the Decision-Usefulness Objectives of Conventional Accounting.

We can therefore conclude that the decision usefulness paradigm of conventional

accounting is flawed because:

1. The theory that provision of conventional accounting information leads to efficient

allocation of resources is tenuous because there are two many ifs in the sequence of

assumptions.

2. Even if information results in shareholder and creditor wealth maximization, this does not

mean better welfare even for themselves, much less for the wider community and society

because material wealth may not necessarily mean better quality of life and welfare.

3. Even in economic terms, decision-user based accounting may be economically harmful

to the organisation providing the information which may even result in social dislocation.

4. The economic environment hypothesised for decision useful accounting is a developed

exchange economy with a capital market focus. This implies that conventional

accounting is only relevant to countries with similar economic environments.

5. The societal assumption of pristine liberal economic democracy (PLED) under which

decision-usefulness makes sense (Gray et al., 1996) is not true even for some capitalist

oriented societies. According to Gray et al (1996), the actuality in these countries is neo-

liberal democracy in which there are groups of unequal power centres. The power gap

between groups have implications on the supposed sovereignty and ability of the

consumer (i.e. the user of accounting information) to make the appropriate decision to

achieve an efficient allocation of resources which might lead to social welfare.

6. THE CHARACTERISTICS OF CONVENTIONAL ACCOUNTING; THE

PROBLEM WITH ACCOUNTING PRINCIPLES


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Financial reports under conventional accounting are prepared according to certain concepts,

which are variously referred to as postulates, principles conventions and concepts. Belkaoui

(1992, p 229) defines accounting principles as general decision rules derived from the

objectives and theoretical concepts of accounting, that govern the development of

accounting techniques. He includes the historical cost, revenue, matching, objectivity and

full-disclosure, conservatism, materiality and the uniformity and comparability concepts as

principles. Belkaoui classifies the monetary measurement and entity concepts as

postulates.

Accounting information produced in accordance to these principles is often put forward as

objective, neutral, verifiable and reliable. However, even the economic consequences

produced by the accounts prepared under these principles were shown to be wanting as

early as 1931 by MacNeal. These principles and concepts have been criticised both from the

capitalist (e.g. Edwards & Bell, 1961; Chambers, 1966; Stirling, 1970) and Islamic points of

view (Abdelgader, 1994) although the latter was at a superficial level (see Adnan & Gaffikin,

1997).

MacNeal (1970, [1939]), argued that accounting was untruthful as it consisted of unsound

accounting principles which he claimed was based on expediency rather than the truth (p

vii). Financial statements prepared under this principles misled investors because it failed

to take into account current values (values in exchange) of assets and instead used

historical (original) costs and justifying them in terms of a going concern theory. According

to him, the unwillingness of accountants to recognise unrealised profits leads the investor to

make wrong economic decisions on lending, buying and selling securities. He further

advocated that all profit and losses whether realised or otherwise should be disclosed (a

position later upheld by Edwards & Bell (1961) and the Trueblood Committee (AICPA, 1973).

MacNeal (1970) argues that the historic cost principle was relevant when businesses were

owner managed, where the function of accounting was counting the costs of a project or

venture. As the project or venture was of short duration, historical cost sufficed to track the

cost and profits accumulated to the end of the venture as no external parties relied on this


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information. The growth of bank credit perpetuated this principle because the bank required

only a conservative estimate of the value of the net assets of the borrower to guarantee the

return of loan. An under-valuation due to historic costs would be that much better and the

conservatism concept would ensure that current assets were written down in value if its cost

was higher than the prevailing market price. Thus, the accounting principles were acceptable

for this period, as the accountant could satisfy both the interest of the banker by being

conservative, and the businessman/owner would not be mislead as the latter knew the real

value of his assets independent of the accountant. The accountant, left with the question of

valuing non-marketable fixed assets invented his theory of the going concern so that he

could justify its valuation in terms of its original cost less depreciation for maintenance and

renewal.

Mergers and Acquisitions led to bigger and bigger corporations controlled by non-owner

management. This led to a situation where many small shareholders were entirely

dependent on financial statements for information to make their investment decisions. The

accounting principles led to the preparation of financial statements which frequently allow

managers and directors of a company to enrich themselves at the expense of the

stockholders in a most comfortable and legal manner.

The prudence and realisation concept is also not appropriate although a fixed asset may be

carried for a long term, investors change during this period. Hence, if investors are not given

the market values, this favours, the insider who can buy up the shares, knowing the real

values of the assets and rake in the profit at the time of realisation, thus in effect defrauding

the previous shareholder who would have sold his shares for a value less than its worth

[SH1].Although the accountancy profession has increased its standards of reporting, overall it

has followed the latter course of redefining accounting objectives. The historical cost,

realisation, going concern and prudence concepts continue to be the bedrock accounting

principles, fifty years after MacNeal wrote his book. Financial scandals continue to rock the

world (Briloff, 1990) and the profession refuses to budge from its basic position with respect

to recognition and measurement conventions despite the increasing audit expectation gap.
http://www.iiu.edu.my/iaw/SHPhDHTMLfiles/Chp_03%20Critique%20of%20Conv%20Acc.htm#_msocom_1%23_msocom_1http://www.iiu.edu.my/iaw/SHPhDHTMLfiles/Chp_03%20Critique%20of%20Conv%20Acc.htm#_msocom_1%23_msocom_1


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The Trueblood Report (AICPA, 1973) tried to change the status quo by suggesting the use

of current values. It rejected the traditional emphasis on prudence and suggest the fullest

disclosure of the uncertainties involved (Peasnell, 1974, p38). Other proposals called for a

middle position between full current value accounting and historical accounting include those

by Lowe (1970) for multiple-column reporting alternate values and the proposal to report

both realised and realisable profits by Edwards & Bell (1961). The Trueblood Committee

Report was rejected because it was too revolutionary.

The monetary measurement concept also produces problems as it implies only activity,

which is measurable in terms of money, are recorded and reported. This may leave out

activities, which are termed externalities because they are too difficult to measure but which

have grave consequences to society. Further, the most important asset, the human asset is

not recorded on a balance sheet.

Besides the economic consequences on investors noted above, Accounting rules have also

social consequences, Tinker (1985) observers that:

Accounting rules though galvanizing and adjudicating social relationships are not

supported by contemplation, reflection, criticism and debate about the nature ofsociety and its potentialities but by expedient reasoning, ad-hoc explanations and

piecemeal rationalizations. (Tinker, 1985, p XX)

Tinker argues that the power of accounting has been underestimated, as has the

accountants responsibility for the social evils through the partisan set of accounting rules

that governs the reporting and disclosure of information about corporations (p xix). Through

the making of accounting rules (standards, principles and concepts) accountants supply one

of the most fundamental ingredients of economic and social choices; the valuation of

alternatives (p xx). Accounting rules attach values to economic choices made by individuals,

groups and organisations thus affecting decision making and thereby distributing benefits

and damage between different members of the community.

The accounting principles also lead to different profit figures for similar businesses. This is

due to the differences in the methods of calculating depreciation and the quantum and timing

of income and expense recognition. For example, in the Pergamon- Leasco Affair where


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Pergamon Publishing Companys profits for the year ended 1968 was certified to be 1.503

million by its auditors. it was recalculated to a 60,000 loss by the subsequent audit of Price

Waterhouse (Lowe & Tinker, 1977). According to them:

About half of this difference was attributable to the method of valuing stocks of books

and back issues whilst the remainder of profits on transfers between affiliated

companies. (Lowe & Tinker, 1977, p271)

These income determination problems become more acute in an Islamic environment

because, Islam does not allow pre-arranged fixed return investments and therefore the

income calculation is the only way to ascertain returns on an Islamic investment. Hence, its

importance.

2.22.2 THE MACRO CONSEQUENCES OF CONVENTIONAL ACCOUNTING

Professional accountants argue that the political and social consequences of accounting

practice should not be considered because accounting strives to be objective and neutral in

social conflict. Accounting records, measures and reports the results of economic activities

of enterprises which are delineated from social activities (AAA, 1966). This separation of

social and economic spheres of activity has already been criticised from an economic

viewpoint, in section 3.2.2 above.

However, the corporation is increasingly seen as not only as a nexus of commercial

contracts but as a moral agent with social responsibilities and functions (Donaldson, 1982) to

a variety of stakeholders (Sutton & Arnold, 1999). Even if managers insist that corporate

functions are primarily economic, the consequences of their economic activities impinge on

the social in terms of their effects on the local community, consumers, employees and the

environment. The activities of Multinationals seem to attenuate these effects to a global

scale. Accounting plays a dominant role in reifying these organisations.

According to Tinker (1985), the image of the accountant as the innocuous bookkeeper,

whose trustworthiness comes from his lack of creativity and imagination , is in fact a mask

which shields accountants and accounting from their impact in the social and political arena


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(p xv). Hence, the power of accounting has been underestimated and the accountants

responsibility for social evils has been and continues to be systematically understated.

Tinker contends that accountants are not harmless bookkeepers but arbiters in social

conflict, architects of unequal exchanges, instruments of alienation and accomplices in the

expropriation of the life experience of others through the partisan set of accounting rules

that governs the reporting and disclosure of information about corporations (p xix) ,

In this context, accounting has been accused of playing changing roles in social conflicts

(Lehman, 1992a) and creating social and environmental disasters (Tinker, 1985), its

principles unsuitable in the context of providing information on ecological issues (Maunders

& Burrit ,1991). It has been accused of creating employment problems especially through

promoting privatization by demonstrating the efficiency of downsized companies using

accounting numbers (Cooper & Hopper, 1988; Arnold & Cooper, 1999). Accounting has also

been accused of directly causing social conflict by increasing the gap between rich and poor

through the wealth distribution effects inherent in the provision of conventional accounting

numbers (Tinker, 1985). Further accounting has also been accused of dehumanizing effects

arising from the construction of the governable person who is a more manageable and

efficient entity (Miller & OLeary, 1987). It has also been accused of promoting gender

discrimination (Cooper, 1992; Reiter, 1997). These injurious practices of accounting have

led Briloff (1990) to charge that accountants have desecrated their covenant with society by

not practicing what they preach in the public interest (Briloff ,1990).

It is difficult to compartmentalise these negative consequences neatly into social, economic

or environmental problems, as they are often intertwined. Tinker (1985) examines

accountings role in perpetuating social and environmental problems by studying several

cases of multinational exploitation, stock price collapses, the dumping of toxic waste, price

gouging by public utilities and the frailties of the world banking system. These cases,

according to Tinker, illustrate accountings camouflage of objective and technical expertise

and expose the disciplines social, human and moral malaise (ibid., p xxi). For example, the


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love canal incident (discussed below) created both social (health and housing) and

economic (loss of houses which were mortgaged to banks) problems for the local

community, the company involved and the government who had to subsidise the community.

It also was a disaster for the environment as it polluted land and made it a health hazard.

The negative social consequences of accounting are emphasised by Marxist writers who

criticise accounting in the historical materialist framework of Marx. They emphasise class-

conflicts. Even within the limited insight of Marxism, the social, environmental and economic

problems caused by conventional accounting which they highlight is of concern to Muslims.

Some of these problems will be examined under the following headings; Multinational

exploitation, privatisation and loss of work and environmental problems. The dehumanising

effects of internal accounting systems are considered under the behavioural effects of

accounting in section 3.5.

Multinational Exploitation

Tinker (1985) examined the accounts of the Sierra Leone Development Corporation from its

inception until its dissolution over a pre and post independence period. Although the

traditional profit and loss accounts shows a profitable operation, behind these numbers lay a

very different social and economic story. He concluded that investment by Multinationals in

developing countries does not benefit the majority of host countries but perpetuated power

groups and elites and destroyed traditional accountabilities. Even in an economic sense, the

host country government and people enjoyed only 15-20% of wealth, and after

independence, this percentage was even smaller (at 11.25%). These economic and social

facts were masked by the accounts as payments to suppliers (for machinery imports,

services and expatriate management). The establishment of the company had also led to

conflict and coercion; using British troops. The local black people had been forced to leave

agriculture due to an increase in local taxes by authorities who were installed by the colonial

administration. The company also bribed local government officials to receive loans and

bailouts (Tinker, 1985).


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This exploitation continues today with the use of transfer pricing and franchising fees.

Transfer pricing accounts for 30-50% of the total revenues of multinationals. The use of

transfer pricing has helped to maximise the after-tax global profits of multinationals because

they provide an opportunity to allocate profits around the world irrespective of the productive

results of the individual subsidiary (Mouritsen, 1995). For example, foreign lumber

companies operating in Papua New Guinea, sell their lumber to associated companies in

Hong Kong at a lower than world market prices in order to reduce payment of local taxes. As

in the Sierra Leone Corporations case, local people are paid miserably lower wages than

the expatriates who occupy the management and technical positions.

The use of franchises allows a company to milk its overseas associates through charging

advisory or franchise fees, which are based on the revenue received, and not profits. These

fees are reported as expenses and sometimes manipulated to avoid local tax. According to

Mouritsen (1995), local governments have to implement benign procedures to control

transfer pricing as they are under the constant threat of withdrawal of the foreign investment

and the ensuing loss of jobs. The establishment and adoption of International Accounting

Standards perpetuate this problem of transfer pricing by multinationals (see Hove, 1989).

Privatisation , Loss of work and Public Property

The Privitisation craze extended the philosophy of liberal economic democracy principles

during the Thatcher and Reagan eras. These heads of states believed that the social

democracies do not work and that welfare state had to be curtailed. There was a political

facet to this because the unions were getting too powerful (rivaling the ruling political

parties). State help to the poor was to be replaced with the equal opportunity of the market.

The free market would henceforth decide wealth creation and distribution. Henceforth state

industries which were inefficient and bureaucratic would go into private hands to increase

their efficiency (measured in accounting profitability terms). Thus, for example, in case of the

water industry, the UK governments white paper on the privatisation of the water industry

suggested that:


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Privatization should lead to improved standards, greater efficiency, and a better

allocation of resources within the water industry. Provided that the customers are fully

protected...the water industry, their customers and the nation as a whole should all

benefit. (Cmnd. 9734, Department of the Environment, 1986, p13).

No mention is made of the protection of workers. The social importance of the water, rail

and even health sectors (henceforth to be called industries) were to be de-emphasised. New

accounting based performance indicators were to be used to gauge their viability. Accounting

was used to prove them inefficient and non-viable, although this was contested by the

academic accountants (Hopper & Cooper, 1988).

Recent studies (e.g. Shaoul, 1997a) have shown that even the economic objectives of

efficiency and the anticipated benefit for all have not been realised. Shaoul (1997a)

critically studied the financial performance of ten water and sewerage companies, which

were privatised in 1989. He concluded that private ownership did not increase the efficiency

of the industry and that ownership was not the most important factor in determining

performance. Further, the privatisation transferred wealth from the public at large to a

relatively few individuals and corporate entities. Consumer found that prices rose by more

than 50%, workers lost their jobs and the nation... made a huge loss on the sale (p 500). A

further more important social effect was that it created the conditions whereby the other

stakeholders will be disadvantaged in the future as the privatised infrastructure was

deteriorating faster than it was being replaced. Shaoul (1997a) also quotes research

showing that in other examples of privatisation, such as that of British Telecom and British

Gas, because of the absence of substantive competition, privatisation did not result in

efficiency gains.

The moral depravity and the social problem of lost work are shown in the study of the

privatisation of Medway Ports (Arnold & Cooper, 1999). In this case, the government-owned

Medway Ports were sold in a Management and Employee Buyout in 1992 under the expert

advice of Price Waterhouse. Dockworkers and other employees bought up to 10,000 shares

valued at 1 each. Later about half the workforce were dismissed and re-employed on a

casual basis. These workers were forced, under the articles of association, to sell back their


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shares to the company as they were no longer employees of the company. The shares were

valued at 2.50 by KPMG Peat Marwick. Six months later, the port was sold to Mersey Dock

and Harbor company for 37 per share which enriched the Directors and financial backers of

the company by millions of pounds. The value of the share had increased from 1 (at which

the Treasury had sold it) to 37 in 18 months. Some employees later sued KPMG Peat

Marwick for undervaluing the shares. The case was settled out of court. The industrial

tribunal found that the company has constructively dismissed the workers but also awarded

them a paltry sum of 10,000 for the loss of security and work conditions and benefits. The

same story is repeated in other cases of privatisations e.g. British Gas, British Telecom and

Water Authorities where Directors are awarded huge executive salaries and perks when the

companies were down sized to affect the efficiency indicators of accounting numbers.

The above cases show the role of accounting in the redistribution of wealth resulting from

privatisation, especially the social implications of accounting and accountants involvement in

privatisation consulting. It shows the role of major accounting firms in the neo-liberal

privatisation program. An Ernst & Whinney report claimed that the Big Six firms were the

dominant providers of privatisation advisory services (EW, 1994 as quoted by Arnold &

Cooper, 1999). According to Hanlon (1994,1996, as quoted b Arnold & Cooper, 1999), the

accounting profession has transformed itself from a semi-autonomous public service

profession to a highly commercialised service industry. Thus:

Accountancy institutions have played a pro-active role in executing transformations

prescribed by the neo-liberal economic agenda. In particular, the consulting divisions of

the major accounting conglomerates have organised, directed and implemented

privatisation on a global scale.(Arnold & Cooper, 1999, p 129).

Environmental Problems

Ecological and environmental problems are increasingly receiving attention as it turns from a

local to a global problem (e.g. Earth Summit at Rio). Many problems, such as the green

house effect, acid rain and damage to sea-life are caused by polluting emissions of industry

and commercialised agriculture. Others result from the transport and the use of fossil fuels

such as oil which is used to drive these industries. Further the consumer culture created by


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mass advertising of corporate products leads to an unsustainable life style which generates

huge amounts of non biodegradable chemicals and other rubbish which has to be disposed

off and drains non-sustainable resources (e.g. oil and other minerals). Hence business has

to play an effective part in controlling, reducing and perhaps reversing the damage to the

environment by using different energy sources, using recyclable raw and packaging

materials, using pollution control equipment, promoting a greener employment and

consumer practices.

Accounting plays an important part in disguising the environmental impact of economic

activities because it only considers financially measurable economic events. Even for these

events, it fails to take into account disposal and winding down and contingent cleaning up

costs. For example, in the case of nuclear plants, substantial expenses are incurred in

shutting down old plants because of the cost of disposing radioactive materials safely. These

deferred costs are not accrued and hence earnings are higher than they should be. Further

social and health costs are passed on to the community and government because they are

termed externalities and are not costed by the conventional accounting system unless there

is a legal liability. Hence, the community bears the social and economic costs of

environmental degradation and not the corporation which caused it.

Maunder & Burritt (1991) argue that the conventional accounting principles of going concern

(entity) , accruals, consistency , prudence and monetary measurement lead to a mismatch

between accounting information and its application to ecological issues. The principles act

to exacerbate or reinforce the primary factors (such as ideologically induced attitudes

towards the desirability of economic growth) responsible for the ecological crises. For

example, the going concern concept excludes externalities (such as pollution emitted by the

organisation) from the measurement of the entitys performance. The prudence (historical

cost convention) induces a backwards looking approach which is less appropriate to

examining future ecological effects such as species extinction as no amount of ex-post

analysis can make these effects reversible. The accrual concept leads to the slicing up of an

entitys life. However, as Maunders and Burritt (1991) observes many ecological impacts


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exhibit lags compared with causal events (e.g. the influence of CFCs on the ozone layer)

(p.11). Thus, the environmental impact of an economic activity of one period may not be

discernible until many accounting periods in the future. In these circumstances, contingent

liabilities need to be disclosed in the notes to the accounts.

An instance in point is the case of the Love Canal (Tinker, 1985). Here, the company caused

pollution by dumping toxic wastes into the Love Canal, which were covered up with earth.

Later a housing development was undertaken on the same land. The residents later noted

serious health problems including miscarriages and premature deaths. The whole area

became uninhabitable, and the residents had to move to another area losing money on their

mortgages as well as suffering health problems.

The company polluting love canal did not disclose, even as contingent liabilities, the cost

incurred in the clean up and upheaval later. Tinker rightly asserts that there are broad

implications of these costs for calculating and reporting period profits. The matter of what

additional costs and when these costs should be reported are not clear. According to Tinker

(1985), the Generally Accepted Accounting Principles under-rate long-term costs and

excludes externalities with their focus on monetary values. Tinkers asks how one can

measure the social and emotional cost of miscarriages or premature deaths (or likewise, the

environmental cost of the extinction of a species) in monetary terms? He therefore

concludes that this understatement of the social costs of corporate behaviour by

conventional accounting makes the claims of objectivity and independence by accountants

spurious.

In some instances, corporations have also used accounting (i) to legitimate their existence

and (ii) to manipulate environmental pressures such as those of anti-pollution regulation and

environmental concerns of stakeholders. One such case is that of Falconbridge (Buhr,

1998). In this case, the Falconbridge Companys smelting process resulted in sulphur fumes

which led to acid rain. In the early part of the Century, the heap roasting method which set

logs alight to burn for 3 4 months, destroyed vegetation (including crops) in the whole

locality converting the surrounding areas into a barren landscape as early as 1901. In 1930,


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the company put up a smelter, which ended heap roasting, but it only served to diffuse the

fumes over a wider area. The mining companies were able to stave off anti-pollution

regulation until 1969, for almost 70 years. Initially, the economic rationality of reducing costs

was used to rationalise the measures to reduce sulphur emissions. Only after legislation was

imposed, did the company set up an Environmental Improvement Project which resulted in

an improvement to its bottom line as a result of technological development. There was

tension between profits on the one hand and pollution prevention on the other, during the

1970s, when technology did not keep pace with regulation. The environmental disclosures

in the corporate reports were scarce in the early years, as there was nothing positive to

report. Buhr (1998) posits that, by focusing on economic concerns and not on the pollution

prevention efforts, the accounting reports were used to stave off further legislation by

showing how costly it was for the company to adhere to the anti-pollution legislation.

However, from 1980 to 1984, the disclosure of improvement in pollution prevention

technology (which had a positive impact on the bottom line) offered an image of an

environmentally friendly company. Later, public opinion had swung so far over to pollution

prevention, that the company openly discussed and emphasised government regulation in its

accounting reports.

As the above case shows, a company can use accounting to (i) legitimate their existence,

trying to change the environment in their favour or (ii) react to the environment when they

are unsuccessful in changing it. Accounts are never used to assess accountability in a

socially responsible way. This is despite the extent of the damage done in the above case,

which was described in the following words:

It will take centuries to repair the effects of logging and smelting, which left Sudburys

landscape looking so much like the moon that the US space agency sent its lunar

astronauts here to train.

(Bailey, 1991, as quoted by Buhr, 1998, p 163)

Despite this, the only considerations at play were technological or financial thus:

What has motivated the process (reduction of sulphur emissions) are the engineers who

just want to make things work better and the financial people are behind it because it ismore profitable.


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(Endicott, 1991 as quoted by Buhr, 1998, p 186)

Lehman (1995), on the other hand, argues that a moral obligation exists to provide additional

environmental information in published accounting reports. In this way, corporations would

satisfy accountability relationships as part of an administrative solution to the environmental

crisis. He argues that through this accountability nexus, accounting would take on the role

of constraining organisational activities, particularly those that may be considered

environmentally degrading (p396). Thus the legitimate concern for fairness (Williams, 1987)

i.e. the moral aspect should establish the need for corporations to disclose environmental

data, not technology, profit and legitimation exercises.

Lehman bases his argument on Rawl's theory of Justice and Political Liberalism. This theory

draws on the sanctity of the individual which is decided by the inter-subjectively shared

group language of the new pluralism. Although this basis may not be acceptable from the

Islamic viewpoint, the researcher supports his call.

Gray (1992) envisages a similar change in thinking and life-style in his call for a radical

reconsideration of current attitudes, structures, beliefs and modi operandi, [to] reintroduce

protection and care for the environment (p 399). He opines that even a pragmatic approach

to survival and sustainability of current human societies forces the realisation that the roots

of Modern (especially Western) society, based on short term human and economic self-

interest, are essentially incommensurable with their continued survival. He blames

conventional economic thought of dominating the conceptualisation, language and

explanation of the world, which influence attitudes and behaviour (negative) towards the

world. He rightly asks what one could expect from the economic decisions of the rational

economic man, devoid of the traits of loyalty, compassion, altruism, sympathy and concern

for others except dehumanising actions and consequences.

THE MICRO CONSEQUENCES OF CONVENTIONAL ACCOUNTING -

BEHAVIOURAL PROBLEMS.


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The implementation of decision-making and control techniques such as budgeting, variance

accounting and performance measurements leads to certain motivations and behaviour

within the organisation. Although these techniques are rationalist-technical in character, the

social consequences can be both positive (e.g. Roberts & Scapens, 1985) or negative

(Argyris, 1953; Richardson et al., 1996). These techniques are meant to achieve goal

congruence between the employees and the organisation, for example, by enabling

individuals to take responsibility (as in responsibility accounting) for their actions and

rewarding or disciplining those who succeed or fail according to the accounting numbers.

When the goals of the organisations are based on utilitarian and marginalist economics, they

may not be compatible for Islamic organisations, which have socioeconomic goals and

values other than profit or wealth maximisation.

Although these accounting techniques on the surface seem to make individuals responsible

for the economic consequences of their actions and decisions, it seems that a rift has arisen

between accountability and accounting which results in negative human and social

consequences. What is worrying is that accounting has been employed as a calculative

practice, as part of a wider modern apparatus of power, is used to construct individuals into

more manageable and efficient governable persons (Miller & OLeary, 1997). Humphrey &

Olson (1995) also view the introduction of the management accounting techniques and

philosophy into the public sector (or its privatised equivalent) as a cause of concern

because the methods being introduced are simplistic caricature of private-sector practice.

According to them, the individualistic enterprise culture, grounded in market-based

philosophy, which accompanies the introduction of these techniques, may lead to overall

reduction in effectiveness and weaken commitments to service and collegial relations.

While these practices may be beneficial for the organisation in the short-term, they have long

term social implications both for the mental attitude and social behaviour of the individuals

affected by such systems. These include an increasing selfishness and conflict, immoral

behaviour, becoming more individualistic and materialistic, becoming susceptible to

manipulations by others, and personal and family problems. Nervous breakdowns and stress


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may also arise. In the long run, the effect on the individuals is reflected in the organisation

which can become schizoid (Richardson et al., 1996) and progress into wider social conflict

(Lehman, 1992a).

The problems associated with conventional management accounting technique of

budgeting , performance measurement and the problem of control will now be reviewed

briefly as these problems of conventional accounting techniques have implications for

Muslim employee and organisational behaviour which may make these techniques

inappropriate for Muslim users and Islamic organisations.

2.2.12.2.1 Behavioural research: human problems of budgets

The human problems with budgeting have long been recognised. In 1952, Chris Argyris

(Argyris, 1953) found that that budgets were viewed as a pressure device to increase

production efficiency by raising workers goals and increasing motivation (to produce more).

He found that budgets being written, concrete, evaluatory instruments, they were used by

supervisors as whipping posts in order to release their feelings about other unrelated

problems. This led to resentfulness among low-level employees (supervisors and workers)

because of the management attitude towards them as a lazy lot out to cheat the company.

This in turn led to formation of groups to counter management pressure. Further budget

pressures led to inter-departmental strife, and tension and unhappiness among supervisors.

Subsequently, budget pressures introduced a fault-finding culture, which created tensions

between line and staff functions. Supervisors could also misuse the budget to express

leadership styles that ends in hurting other people. Argyris (1953) suggested a more

participatory budgeting system. However, although Argyris noted the narrow-minded, figure

conscious nature of accountants he failed to question the notion of efficiency itself as a valid

objective.

In a more recent article, Argyris (1990) asserts that the use of accounting controls results in

conflicts between those who use the claim of objectivity and rigorousness to defend

accounting and those who use accounting but disbelieve the claim. The discussion of the


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conflict could lead the players to feel embarrassment or threat. Using budgets to compel,

force, search out mistakes can lead to activation of organisational defensive routines , such

asgaming, smoothing, filtering, biasing, focusing, and illegal acts, that by pass the cause of

the threat and cover up the by-pass.

Hughes (1965), notes another problem with budgeting, that of padding the budget. This is

particularly problematic if managers threaten sanctions for over-spending. If each level of

management punishes the next lower level for overspending, then each level will add

contingencies to its estimates, inflating the total budget.

While accounting control techniques results in accountants becoming coercive, fault-finding

and threatening, and creates tensions and pressures on line supervisors and workers, it

also leads to dysfunctional effects (violation of system rules and procedures) on other

departmental managers as well (Jaworski & Young, 1992). In a survey of 500 marketing

managers, they found that when the individual internalizes the goals, values and beliefs of

the organisation, his actions are more likely to correspond with the activities desired by the

firm. In turn, as person-role conflict decreases, job tension decreases with a consequent

reduction in dysfunctional behaviour. Conversely, the reverse is true.

Management Control and Performance Measurement

A management control system has been defined as :

A system of organisational information seeking and gathering, accountability and

feedback designed to ensure that the enterprise adapts to changes in its substantive

environment and that the work behaviour of its employees is measured by reference to a

set of operational sub-goals (which conform with overall objectives) so that the

discrepancy between the two can be reconciled.(Lowe, 1971, as quoted by Otley, 1995, p 47)

[2]Gaming refers to an action, which will achieve the most favourable outcome regardless of the action that thesuperior prefers For example, salesmen can increase volume to show good personal performance at the expense

of lower profitability or increasing bad debts. Smoothing occurs when subordinate utilises the information

system to his benefit by altering the natural or pre-planned flow of data without altering the actual activities of

an organisation e.g. transferring expenses and revenues from one period to another. Filtering information occurs

when subordinates report only the more desirable elements of a set that favourably reflect on themselves.

Illegal acts include falsification of information where existing information is intentionally altered or fed into an information

system.


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The limitations of an accounting approach to control systems are recognised by Otley

(1995). In criticising Anthonys (1965) emphasis on accounting control systems, he observes

that a useful Management Control System cannot confine itself solely to accounting

measures of performance. It should also take into account the non-financial and technical

measures of performance and those areas of performance that cannot be measured in

precise, quantitative terms. However, the example of such areas, he quotes i.e. market

share and competitive position, are still profit oriented measures.

The cybernetic or feedback control system is the most often used model for accounting

control (e.g. Berry et al., 1995). However the effectiveness of this cybernetic model has been

found lacking in effectiveness and attributed to failure and hence in need of revision (Dermer

& Lucas 1986). Dermer & Lucas (1986) assert that managerial control is an illusion, which

fosters the belief among managers that conventional controls such as operating standards,

profit targets, and budgetary criteria accurately and validly measure and determine

behaviour. Quoting Hofstede (1978), they assert that prior social conditions

implied by cybernetic models or the social consequences of such models have not received

the attention they deserve. There is a focus on the manager as the sole causal agent,

denigrating and the degree to which non-managerial agents really influence outcomes. Thus,

they wrongly assume that the unilateral exercise of power is control- irrespective of the

effects these changes may produce.

Neimark &Tinker (1986) observe that management control systems, until then, have been

heavily influenced by neo-classical economics and organisation theory, thereby ignoring the

social origins and the social consequence of corporate control systems. Using the Marxian

dialectical approach in a case study of the internationalisation of General Motors, show that

corporate control systems are not just the consequences of exogenously determined forces

but also agents of social change. This is effected through the chain of events, which are a

consequence of the corporations decisions to further their own self-interests. The

consequence of the control system does not only affect other corporations but also ultimately

affect the originating entities.

Ch 3- The Problems With Conventional Accounting

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